Is The Santa Claus Rally For Real?

Investors are taught never to use hope as a reason to invest, but after 2011 that has left the majority of professional money managers lagging the market, the hope of an upcoming Santa Claus rally is palpable in the investment markets, as we enter the early days of December. What is it and what does it mean for your portfolio? (For related reading, see The Frosty, Festive World Of Investing.)

What Is It?If there is an academic explanation that explains a Santa Claus rally, it would be a strong move to the upside that occurs between Christmas and the New Year. There are as many explanations for this rally as there are lights on a Christmas tree, but some of the more common include the euphoria of the holiday season and excitement about the New Year, positioning portfolios for maximum tax benefits, and the absence of some of the market's more pessimistic traders who are still on vacation.

This year, the Santa Claus rally has been extended. On November 28th and 29th of 2011, when the S&P 500 added more than 3%, financial media including CNBC, called it the beginning of the Santa Claus rally. It seems that Santa is expected to come earlier this year. (To learn more, read Support And Resistance Levels To Watch.)

Show Me the FactsIf the Santa Claus rally is real, the facts should support it, and according to Bespoke Investment Group, they do. Going back to 1990, December has seen average returns of 2.02% with positive returns 81% of the time. In the past 100 years, the average December return is 1.39% with positive returns 73% of the time.

Only July has seen a better 100 year return, edging December by 0.01% at 1.40%, with positive returns 61% of the time. Bespoke believes that because professional investors have underperformed the market this year, they will be more likely to commit money in December in an attempt to capture last minute returns. (For related reading, see Capitalizing On Seasonal Effects.)

Is it Different This Time?Some investors doubt that Santa will deliver the rally that investors are hoping for. The European debt crisis has kept a lot of money on the sidelines and without any positive news in sight, any large scale gain in the market could result in a whipsaw to the downside, if any bad news emerges from Europe.

Investors also cite the failure of Washington's Super Committee, and how that is one more example of how Washington is too divided to make bold moves that could address the 9% unemployment rate (as of Oct., 2011), mounting debt and historically low home prices. (To read more on Washington's Super Committee, see Can The U.S. Super Committee Solve The Debt Crisis?)

There is also concern about the Bush era tax cuts expiring and the weakness of the financial sector that caused Standard & Poor's (S&P) to downgrade the credit ratings of some of the major banks, including Bank of America (NYSE:BAC), Morgan Stanley (NYSE:MS), Wells Fargo (NYSE:WFC) and Citigroup (NYSE:C).

The Bottom LineFor those who believe the statistics, the chances are high that Santa Claus will deliver the gift that the markets are looking for this year. If you believe in the fundamental picture of the global economy, it may be best to limit exposure this month. (Do you know when you're going to retire? It might not be as soon as you think. Read The New Retirement Age.)